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Portfolio > Economy & Markets

The Panama Papers and a Troubled World Economy

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The leak of some 11.5 million documents from the Panamanian law firm Mossack Fonseca has triggered outrage around the world. There has been speculation as to how revelations about large offshore holdings belonging to politicians and schemes to avoid paying taxes employed by the superrich will feed into the wave of anti-establishment political sentiment swelling around the world as well as resentment for the supranational caste of “one percenters” — as evidenced, in particular, in the current U.S. presidential campaign.

The remarkable sweep of tax avoidance and the scope and reach of the global network facilitating the movement of gray funds across national borders suggest a bigger problem that transcends individual wrongdoing. Some estimates suggest that more than $20 trillion has been stashed in offshore accounts.

The real culprit is the relentless creation of liquidity by major central banks. Money pumped into the world financial system, especially since the 2008 financial crisis, has undermined political systems in emerging economies. However, the damaging effects of the uneven distribution of wealth — the creation of the super-rich class and unprecedented expansion of corporate profits as a share of GDP on the one hand and the disintegration of the middle class on the other — are being increasingly felt in rich industrial democracies, as well.

Robbing One’s People

The leaked papers from Panama have named names and ended or damaged political careers. But they didn’t reveal anything new. With a couple of notable exceptions, the affair has been focused on third-world countries, most with a history of politicians keeping their hands in the public till. The longer such public servants remain in power, and the less opposition they face, the more shamelessly they steal.

Nor is it major news that corrupt politicians like to keep their money hidden from view, and that rich people like to evade taxes. Banks in Switzerland, Luxembourg and Lichtenstein used to cache illicit cash in previous generations.

The real takeaway from those revelations is the unprecedented scale of the pilfering. One estimate puts illegal capital flight from developing economies at around $8 trillion in the 10 years between 2004 and 2013, the equivalent of India’s, Brazil’s and Russia’s GDP combined, with Germany’s GDP thrown in. That was also a decade of bloated commodity prices. The sum represents a good chunk of super-profits those developing economies earned by exporting commodities.

Pervasive corruption has undermined development. In 2001, Jim O’Neill of Goldman Sachs coined the term BRICs to include Brazil, Russia, India and China. Those large, populous countries were expected to dominate the world economy by the middle of the century, and provide the bulk of global growth in the interim. During the ensuing dozen years, this forecast seemed to be coming true as the BRICs grew at a remarkable pace.

But now all of a sudden their future is looking a lot less rosy. Two of the BRICs, Brazil and Russia, are in a recession and even China’s growth model has started to sputter. Politicians in all three of those countries have been tainted by massive corruption. In Brazil, the country’s previous president is under investigation for massive corruption and his hand-picked successor, Dilma Rousseff, is facing impeachment. Neither was mentioned in the Panama papers, but a large number of other politicians were. The seven parties they represent include a former government coalition partner and the largest opposition party.

Ton of BRICs

Russia’s president Vladimir Putin has been a particular focus the Panama leak. While his name wasn’t mentioned directly, there can be little doubt that some $2 billion poured into offshore companies, nominally owned by an obscure cellist and Putin’s childhood buddy, actually belonged to the Russian president. This included kickbacks from rich Russian oligarchs and state-owned companies. Moreover, it is probably only the tip of an iceberg, since Putin’s secret fortune, amassed since he became Russian president in 2000, has been estimated upward of $40 billion.

High Russian government officials, including regional governors, members of parliament and even Putin’s personal spokesman, were also found to have offshore accounts and companies. Since 2009, over $500 billion has left Russia, with outflows averaging 3% of GDP a year.

And then there is China. China arrests and executes middle-level officials and businessmen for corruption with remarkable regularity. However, a number of top-level Chinese Communist Party officials, including top man Xi Jinping, have been implicated — or at least their relatives have been tied to shell companies set up by Mossack Fonseca. Almost one-third of the firm’s business came from China, and Chinese and Hong Kong residents are its largest clients. Until recently, private capital used to flow into China, but last year, the country suffered an outflow of $500 billion.

What does all this have to do with monetary ease and, in particular, with the quantitative easing policy pursued by the U.S. Federal Reserve? In the 1970s, easy money triggered a bout of high inflation: workers got wage hikes, which pushed prices higher and triggered demands for more wage hikes, creating an inflationary spiral. By contrast, the Fed grew its balance sheet by $4 trillion in the 2008–14 period, but wages stayed low, keeping inflation under wraps. Instead, extra money went into asset prices, creating speculative bubbles. In particular, commodity prices, spearheaded by oil prices, went through the roof.

Commodity exporters received a fabulous windfall. Oil-exporting nations lived high on the hog as oil prices averaged above $100 per barrel, but China in effect was also selling a commodity: its boundless supply of cheap, highly organized labor. China has been a major beneficiary of U.S. monetary ease. Since 2000 its cumulative trade surplus with the United States totaled $3.5 trillion as America’s ability to print dollars — and China’s willingness to accept them in payment for its exports — allowed Americans to consume more than they produced.

Demand from China helped inflation bubbles in commodity markets. Brazil was just one among a variety of commodity producers in South America, Africa and the Middle East that prospered over the past decade by selling to China.

Political Bargain

A substantial portion of the windfall inevitably trickled down to the population. China’s annual wages nearly tripled in the decade since 2006, and hundreds of millions of peasants who had been living in extreme poverty moved to the cities, bought consumer goods and put aside savings. Since the Tiananmen Square uprising quarter of a century ago, the government in Beijing has offered its people a bargain: we let you live better while you let us rule without asking too many questions.

A similar bargain was struck in Russia, Brazil, Venezuela and various other countries. Consumers enjoyed a rising standard of living thanks to the flow of money from commodities, while ignoring official corruption and bribe-taking. No one paid much attention to the fact that the prosperity was mostly the function of an unprecedented — and unsustainable — jump in commodity prices underwritten by the running of the printing press by the Fed and other major central banks. Billions of dollars were not invested into long-term, sustainable development; instead they were siphoned off to offshore accounts or went to pay for luxury real estate in New York, Miami and London.

Pumping money into the financial system by pressing a button on a computer, as world central banks have been doing for eight years, can’t go on forever. The Fed wound down its QE program between December 2013 and October 2014; not coincidentally, commodity prices plunged — for instance, oil fell to one-third of its value. In December 2015 the Fed effected its first interest rate hike in a cycle. The world economy, which has been stagnant over the past couple of years, is now starting to show signs of a downturn.

The Panama papers merely confirm what ordinary people in emerging economies are starting to realize: that they have been misgoverned and that their rulers have been mostly interested in stuffing their pockets. It suggests a period of considerable political instability (which we are already seeing in Brazil) as well as massive repression. Since the scandal broke, Putin has announced the creation of a National Guard that will have the authority to shoot protesters without warning.

The unprecedented period of monetary ease has also created a skewed distribution of wealth and incomes in industrial nations — especially the U.S.

Our politicians may not be as blatantly corrupt as their counterparts in developing nations, but there is a strong feeling that the super-rich are not paying back into the system that made them wealthy; that the financial services industry, which was bailed out in 2008 with taxpayer money, is failing the ordinary consumer while enriching those closest to the central bank’s printing press; and that corporations, while steadily growing profits as a share of national income, are not investing in the economy and are instead rewarding their senior management.

The presidential election has shown the depth of discontent with the country’s economic system and its political establishment. While no U.S. corporations, politicians or wealthy individuals have been named in the Mossack Fonseca leak, the papers confirm that the rich and powerful all over the world are gaming the system in their favor. Nor is it a foregone conclusion that there won’t be embarrassing revelations going forward: there are some 3,000 U.S. and 9,000 British individuals and entities among the firm’s clients. If only $8 trillion of offshore funds has come from developing nations, this means that some $13 trillion of the total sum on offshore accounts belong to residents of rich developed countries.


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